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The birth of business models

17 March 2010

The term business model only really entered the mainstream in the 1990s, when so many unfamiliar ones emerged. Earlier inventors of revolutionary models like Henry Ford (mass production) and Frank McNamara (credit cards) just thought they had come up with a good business idea. Now business model innovation is analysed by academics and, according to IBM’s annual survey of CEOs, is a top priority for most global companies.

This is all very sensible. I just wish I could think of a great new business model that was the outcome of careful process and systematic analysis. Finding a business model was one of the critical phases in the birth of all the businesses I studied who created entirely new markets, but in every case it emerged gradually, often serendipitously, and was rarely the starting point. The genesis of the model is often indistinguishable from that of the business itself, which in most cases was the product of trial and error rather than anything resembling strategic planning.

The two most profitable business models on the Internet, eBay and Google, are the most extreme examples of serendipity and good luck. In both cases the founders’ insistence on putting the interests of users first, rather than seeking to maximise revenues and profits, was rewarded by a bonanza.

eBay only became a business by accident – it was originally a free online auction service for computer geeks like Pierre Omidyar that only started charging when traffic got too heavy for his ISP. Omidyar and his partner, Jeff Skoll, did not consciously invent a business model, but finding themselves at the hub of an enormous virtual network, where all the work of delivering goods and collecting money was being done by ‘the community’ turned out to be like striking oil.

Google took longer to find a business model. Its founders knew when they incorporated Google Inc in 1998 that its search engine was far superior to those of the then market leaders, Alta-Vista and Excite. But even when it became the most popular on the Web in June 2000, they were still not sure how they would make money from it. Their first thought was to license the technology to others but nobody was very interested in improving search then. Alta-Vista and Excite thought that the way to maximise advertising revenues was to keep users within their portals as long as possible. Page and Brin feared that advertising might prejudice the interests of users. However, when they discovered an unobtrusive form they could live with, revenues rocketed, and reached $86 million in 2001. In 2002, when they modified the ad model to an algorithm based on auctioning keywords, they accelerated to $439 million, and in 2003, $1.5 billion.

What made both these models so lucrative was exponential growth, thanks to powerful network effects and feedback loops. But they would never have come into play without a large measure of youthful idealism.

The birth of Amazon was much more systematic and analytical, but the business and its processes, strategy and model all evolved together in the light of experience. The first big switch came in 1997, two years after launch, when sales hit $16 million and the IPO raised hundreds of millions. Instead of steadily pursuing profitability as an online bookshop, the strategic imperative now was Getting Big Fast and becoming an all-round ‘e-commerce destination’. A frenzy of expansion and acquisitions almost ended in disaster when NASDAQ crashed in 2000, but Jeff Bezos promptly switched course and made profitability the immediate priority. Since that period of crisis, he has shown that the e-commerce destination model was a valid long-term one for a brand as strong as Amazon’s. The margins on books remain meagre, but only half of its sales, which reached $24 billion last year, now come from books, DVDs and music. Goods sold on behalf of third parties, where its model is much closer to eBay’s, helped net income reach $902 million in 2009. And if Kindle and its other recent venture, providing Cloud computer services to businesses, prove successful, the model will evolve further.

It’s not just Internet businesses whose models evolve in line with their strategies. Nokia’s embrace of mobile telephony in the 1990s is most remarkable for the way it built on its mastery of digital technology and the GSM standard to develop entirely new capabilities in design and consumer marketing. A major part of its strategy, which it took Motorola and Ericsson, the previous leaders, years to grasp was that the important customers now were consumers rather than network operators. The extraordinary growth in volume also required radical changes to the supply chain and a new set of relationships with suppliers.

BSkyB lost so much money in its first three years that it almost brought down Rupert Murdoch’s entire business empire. Its salvation was winning the rights to Premier League football in 1992, but equally radical was the shift to a subscription model. This proved to be much more profitable than anyone had ever imagined, as Sky’s sophisticated subscriber management system and wily bundling of programming enabled it to extract ever more money from its subscribers. Once it had made itself the standard in the new medium, it became a wholesaler as well as a broadcaster – content owners and cable operators were obliged to deal with the new gatekeeper.

In all these cases, business model is inextricably bound up with strategy, and subsidiary to it. Who is selling what to whom, and why, is as fundamental a part of a model as how suppliers actually make money. Those who have made the most money have generally been the most nifty, creative strategists. And mostly they made it up as they went along.

4 comments to The birth of business models

  • 1. You have no competitor. If you acknowledge them as a competitor than your product becomes a commodity. Commodity wars are won on lowest price.2. What does your product do that no other product does? Why is this important to a buyer? Position around this.3. Become the expert. You must be the recognized leader in your industry. People will pay more for the items the expert/leader sells.4. Market, market, market!Good luck! Thank you for this article! I’ve just found a really good news archive about real marketing Try it!

  • Thanks for a great post, I never thought of it like that before.

  • Amy

    1. You have no competitor. If you acknowledge them as a competitor than your product becomes a commodity. Commodity wars are won on lowest price.2. What does your product do that no other product does? Why is this important to a buyer? Position around this.3. Become the expert. You must be the recognized leader in your industry. People will pay more for the items the expert/leader sells.4. Market, market, market!Good luck! Thank you for this article! I’ve just found a really good news archive about real marketing Try it!

  • Lucy Scire

    Great response!!!! I agree, besides apple always seems to be ahead of the game, so if the iPhone is lacking in one area it excels in many others. I love my iPhone and I have not read anything that made me even consider a different phone.

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